The potential for decentralized federalism to efficiently allocate public resources is also uncertain. Five conditions must hold for the decentralized public economy to be economically efficient: 1) Publicly provided goods, services, and regulatory activities must be provided at minimum average cost; 2) There must be a perfectly elastic supply of political jurisdictions, each capable of replicating all attractive economic features of its competitors; 3) Households and businesses must be fully informed about the fiscal and regulatory policies of each jurisdiction; 4) Mobility of households and businesses among jurisdictions must be costless; and 5) There can be no inteijurisdictional externalities or spillovers. When condition 1 is violated, the community’s activities become “public goods.” Without condition 2, fiscal competition can lead to the misallocation of labor and capital (Boadway and Flatters 1982). If families and businesses do not know the full implications of government policies (violating condition 3) or if there are significant relocation costs (violating condition 4), then the current community can “exploit” residents and firms through higher taxes or lower services. Finally, when there are inter-community production or consumption spillovers (violating condition 5) local services may be under-provided (positive spillovers) or over-provided (negative spillovers). The solution in each case is to look to a central government to manage the resulting misallocations.

In decentralized federalism, Coase bargaining is the approach used to set central government policies. For successful Coasian bargains to occur, five conditions must be met: 1) There must be no, or very small, resource costs associated with the bargaining process; 2) Preferences over bargaining outcomes and the resources of households must be common knowledge; 3) Bargaining agents must represent fully the economic interests of their constituents; 4) All bargaining agreements must be costlessly enforceable; and 5) The parties must agree to a division of the bargaining surplus. Condition 1 seems defensible. The agents for bargaining – elected local government officials – are already in place in the Tiebout economy; the marginal costs of using these representatives to negotiate additional political agreements are likely to be small. Meeting conditions 2-5 seem more problematic. If the preferences of each local representative to the central government are not common knowledge (violating condition 2), then there will be strategic advantages to concealing true benefits and costs and no agreement may be forthcoming (Crawford 1982). There is no guarantee that an elected local representative will choose to represent that group harmed by an inefficient out-of-state policy if the affected citizens are a minority; condition 3 is then violated. Failure to enforce inter-community bargains (violating condition 4) is likely to be problem only when important contingencies which might affect the agreement cannot be foreseen in advance, creating incentives to break a necessarily incomplete contract at a later date. Such behavior also discourages initial agreements. Finally, local representatives may not be able to agree on how the economic surplus generated by inter-community exchange should be divided (violating condition 5). One jurisdiction can reject an economically beneficial offer from another jurisdiction simply because the proposed offer, even though efficient, violates the first’s community’s exogenous, and no doubt politically motivated, sense of economic fairness (Roth 1985). The hope that voluntary inter-community Coasian compacts might ensure an efficient allocation of resources when the Tiebout economy fails seems optimistic. A centralized federal constitution offers an alternative.